Sorry Bond Lords, Venezuela Is a Dictatorship Now

Nicolas Maduro, president of Venezuela, right, and Raul Castro, president of Cuba, shake hands during the Non-Aligned Movement (NAM) Summit in Margarita, Venezuela, on Saturday, Sept. 17, 2016. Maduro moves faster towards creating first dictatorship in South America since the 1980s. (Photographer: Carlos Becerra/Bloomberg)

Venezuela is a dictatorship now.

The leftist government of Nicolas Maduro said Thursday that there will be no recall referendum to hold early elections. He also barred opposition leaders from leaving the country, in a move that some say may eventually lead to political persecution of his rivals.

In early September, millions of Venezuelans emptied out into the streets calling for the recall referendum. The Venezuelan economy is in the gutter. Inflation is triple digits. Food is scarce. There is an unprecedented brain drain. And the country's most important enterprise, oil firm PdVSA is on the cusp of default.

Thursday's killing of early elections means Maduro will be in power until 2018. But if he feels his Socialist Party of Venezuela (PSUV) will be losers in those elections, chances are high, judging by his behavior, rhetoric and hard left ideology, that he is not going anywhere. Oddly, as his role model Cuba opens up gradually to the U.S., Venezuela is in the process of closing its doors.

What does it mean for PdVSA bonds if Venezuela opts out of paying those bills?

Maduro blows a kiss during a rally with PdVSA workers outside the Miraflores presidential palace in Caracas as a poster of Hugo Chavez hangs in the background. (Photo by JUAN BARRETO/AFP/Getty Images)

PdVSA defaults, what does Venezuela use to financing the government?

It means the government will -- or at least should -- default as well, as they’ve lost any chance of market access so paying debt will simply be a waste of remaining reserves. It leaves them three things for financing: reserves (around $12 billion), borrowing in local currency whose issuance is already creating hyperinflation, or running arrears. All of these options are bad. On outstanding payments in arrears...a default would likely kill that.

Will China swoop in to the rescue?

China might be another source, but we think they won't give more credit until Venezuela clears those payments in arrears with China, and do reforms.

As an aside, Venezuela's current account is in balance, so Maduro may not need external financing. Plus it has enough in its central bank reserves to pay debt service on PdVSA's 2017 and 2018 bonds, totaling around $4 billion on the high end. PdVSA needs oil prices to be around $40 to $45 to be profitable. But their oil production is declining at a rate of 10% per year.

It looks like Maduro is here until 2018. What are the risks of the 2018 election being canceled? This would have a major impact on PdVSA's longer dated bonds like the 2022s.

The 2018 elections might not get held, you are correct. Venezuela becoming an isolated dictatorship is a scenario. Maduro may stand for election if he thinks he can win. He is more popular than Dilma (Rousseff) when she was pushed out in Brazil. Either way, the constitution no longer matters as the supreme court has shredded it. If they default, PdVSA bonds will start trading at recovery value and the price curve will flatten. Also, investors will start to think about all the other claims that will get wrapped into whatever eventual restructuring…which are large and can take a long time. We see Maduro staying. He’s useful to the military. If he goes, we see the military taking over. They are the true rent-seekers benefiting from the mispriced exchange rate and all these other bad policies.

Is a PdVSA default like a sovereign default? What recourse do investors have if PdVSA bails on its obligations?

First, the government would have to default on its bonds in addition to PdVSA, which we expect they will do anyway. That would make it technically a sovereign default. A PdVSA default is not a sovereign default of the government. When it defaults, you sue in New York courts and it is probable, in our opinion, that PdVSA gets ruled an 'alter ego' of the government so both debts will represent identical or similar claims.

How ugly does this get? Investors have had it with South American oil companies and their corrupt governments.

I wouldn’t be surprised if you see new precedents in terms of being able to seize oil assets on boats, because the U.S. government is going to be very anti-Venezuela obviously. For sure Citgo refineries get seized. Note that PdVSA bonds don’t have a collective action clause (CAC). Venezuela does, other than its 18s and 27s. Those non-cac Venezuela government bonds will be an interesting opportunity at some point. But the main point is non-cac makes any renegotiation trickier as we saw in Argentina. It’s conceivable that Maduro switches rights of oil to some new company. But that probably doesn’t matter. The new company will have no access to capital.

Socialist dreamboat Maduro may be playing with fire. The economy is so destitute that it may require an International Monetary Fund bailout. Such a move would put Maduro at the mercy of the U.S. and an institution that will demand reform, or no bailout.

He clearly knew he had no chance in early elections. Even poor Venezuelans hooked on the mythology of Simon Bolivar reincarnate -- the late Hugo Chavez -- are not great enough in number to hand Maduro a victory in the voting booth. He did not want to risk the recall referendum vote so his government canceled it. It is as simple as that.

There has yet been no formal reaction from the opposition as of Friday.

Venezuelan Government' supporters in 'communist red' clash against Maduro opponents during a demonstration to demand a recall referendum against Maduro on October 12. Maduro killed the referendum vote on Thursday setting the stage for autocratic rule possibly beyond 2018 when Maduro's term ends. (Photo by STR/AFP/Getty Images)

Maduro's PdVSA's default threat and the killing of the referendum vote now becomes a political gamble. He has chosen to outright deny voters an expression of their democratic rights.

"More than any other previous violation of democracy, this is the most blatant and will test the reaction from moderate factions from within the PSUV party and the military," says Siobhan Morden, a Latin America fixed income strategist at Nomura Securities. She may have found her Venezuelan match in Eric Fine at Van Eck.

There is now no obvious path towards a democratic transition other than a sudden and forced intervention. There are higher stakes for the public and for investors in PdVSA now that Maduro is choosing the path of Cubanizaation.

Welcome to Havana, PdVSA bond holders.

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I've spent 20 years as a reporter for the best in the business, including as a Brazil-based staffer for WSJ. Since 2011, I focus on business and investing in the big emerging markets exclusively for Forbes.